There Are Some Reasons To Suggest That AS Baltika’s (TAL:BLT1T) Earnings Are A Poor Reflection Of Profitability

Shareholders were pleased with the recent earnings report from AS Baltika (TAL:BLT1T). However, we think that investors should be cautious when interpreting the profit numbers.

Our analysis indicates that BLT1T is potentially undervalued!

A Closer Look At AS Baltika’s Earnings

Many investors haven’t heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company’s profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company’s average operating assets over that period. The ratio shows us how much a company’s profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it’s worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, “firms with higher accruals tend to be less profitable in the future”.

AS Baltika has an accrual ratio of 1.10 for the year to September 2022. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn’t produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of €1.8m despite its profit of €3.38m, mentioned above. We saw that FCF was €3.1m a year ago though, so AS Baltika has at least been able to generate positive FCF in the past. However, that’s not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part. The good news for shareholders is that AS Baltika’s accrual ratio was much better last year, so this year’s poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of AS Baltika.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it’s not overly surprising that AS Baltika’s profit was boosted by unusual items worth €7.3m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that’s exactly what the accounting terminology implies. AS Baltika had a rather significant contribution from unusual items relative to its profit to September 2022. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On AS Baltika’s Profit Performance

AS Baltika had a weak accrual ratio, but its profit did receive a boost from unusual items. For all the reasons mentioned above, we think that, at a glance, AS Baltika’s statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. If you’d like to know more about AS Baltika as a business, it’s important to be aware of any risks it’s facing. Our analysis shows 4 warning signs for AS Baltika (3 are a bit unpleasant!) and we strongly recommend you look at these before investing.

Our examination of AS Baltika has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.